You state: “but remember if i sell a home 250/month for 48 months at 0% and you sell that same home for 60 months @ 18% (or whatever) the ONLY time you bring in a penny more than me is at month 49 PLUS you have to pay a load on your schedule B (assuming your doing a lot of deals) and i wouldn’t.”
If I sell for the same total $12,000 over 48 months (15% int) My sale price is $8,900.
two advantages.
A) my price looks like a better deal.
b) I pay lower cap gain taxes up front and spread the tax burdon over time.
In all your post you fail to look at cap gain tax.
If you assume the homes sell at the same price then the advantage still falls to the 15% interest senerio.
a) if home comes back… more basis is left in home… thus lower cap gain tax in the second go around.
b) if the tenant goes full term them much more mone is made.
bare with me because my thoughts are clear in the head and ill try and make them clear here…
so ive been in the business full-time for almost 2 years now and interest rates (or better yet what rate to charge) have been something ive spent many hours thinking about
alright so im selling a bunch of homes and as is the business, some come back and given the recent discussion on “flakes” and the fact that the vast majority of these homes will come back, i’ve been thinking why charge interest (or at least high interest) on these homes?..ill explain
first of all i realize that interest is the charge made on money you loan out but in the case of a Lonnie Deal, you don’t lend any money you simply sell an asset on payments
well lets make some assumptions…lets say you have a home that you want to get 250/month out of, well unless you KNOW the loan will mature than the interest you charge is just extra money you have to pay the IRS right? if i want 250 a month for 48 months 0% and you want 250/month for 60 months 15% but both the people flake out after 12 months i get 3000, you get 3000 but i pay no interest on my schedule B, you do and more importantly an escallating amount the higher rate of interest you charge!
i was raising the interest rate i was charging to around 17.75% until it came tax time and realized i was paying a bundle in interest charges on home that did not, or i was pretty sure would not, ever mature
now i like to think im a pretty intelligent person so here’s hoping someone in the first reply doesn’t throw out something to kill my thinking and make me look like a fool but i know there’s some great minds on this board so i’d love to hear some thoughts
plus i usually just provide input so i figure im due to arrouse some discussion!
My tax background causes me to disagree with a couple of your viewpoints
“in the case of a Lonnie Deal, you don’t lend any money you simply sell an asset on payments”
there are two profit streams from the Lonnie Deal; hence, two ways for Uncle to hold his hand out: the gain from purchasing correctly and selling correctly and then the profit made from receiving your purchase price as a stream of payments rather than a lump-sum up front. Based on what I am calling the second profit stream you ARE lending money and interest is the compensation for your lost opportunity cost. I think it is a mistake to just call this “extra found money.”
“but i pay no interest on my schedule B”
over the course of time if you do not show interest on your Schedule B then in my opinion you are running the risk of having the IRS recalculate your interest for you based on their schedule of imputed interest rates where THEY set the “market” rate of interest for you for tax purposes. Not such a big deal in the case of one year’s returns; but, if they catch it after several years then the related penalties and interest charges could make the entire venture a costly rather than profitable way of spending one’s time. If one were going to make zero interest a part of the deal on a regular basis then I would suggest consulting a qualified tax person who is willing to argue the treatment in front of the IRS; this provides you an extra level of protection through their errors & ommissions insurance in the event that the argument does not fly. The standard for a tax professional in such a case requires their professional judgement to believe that the argument has roughly a 1/3rd chance of holding up. You could have an interesting argument to the IRS though if you could show that your experience is that only X% of the loans actually go full-term.
I’ll add that I am not against the zero interest scenario; and it is in fact discussed by Lonnie in one of the books…can’t remember whether DOW or the second one. I do think it is better to be prepared up front with tax planning rather than doing damage control on the back side.
Having just read Tony’s referenced thread I whole heartedly agree that the interest rate vs. purchase price largely is a shell game with the ability of the seller to adjust to whatever the buyer’s issue is; most convenient if you are the seller and why my life’s goal at this point is to be the seller rather than the buyer :-).
One could also make the observation that improvements in the screening process might help more deals go to completion. Though, it may not be your goal as receiving multiple down-payments from the same unit is pretty nice Really just a determination of what your business model is and how much you want to hassel with turn-over.
Re: so let’s discuss interest rates… - Posted by Michael(KCMO)
Posted by Michael(KCMO) on May 09, 2007 at 22:11:49:
An interesting perspective, Adam. I’m not a tax guru by a long shot but what you’re saying about that part of it makes sense to me. I may be missing something obvious - like I said, I’m not a tax guru.
Off the top of my head, though, I would still bet I’ll make more by charging interest. I might pay a little more in taxes, but my default rate is less than 25%. I DON’T get “the vast majority” back. My majority pays their home off. Given that fact, the interest charge is extra profit for me. I’m not queasy about letting them know my rates are high - 14.5 to 18%. I tell buyers, “I’m not the cheapest. If you have a way to borrow other money and pay cash that would definitely be the route to go in order for you to save the most money. I’ll even give you a discount if you can. But I’ll bet I’m cheaper than your credit card.”
Another facet to consider is if you sell the note. An investor is going to want a yield of X%. I’d rather have a good portion of that X% covered by the interest I’m charging rather than from a discount in sales price/face value. I haven’t sold any notes but I have thought of that.
Good question. I look forward to hearing other’s responses.
on the 0% interest i was doing that to make a point of the cost of having high interest and i understand that the IRS isn’t stupid so you have to charge a rate that makes sense
also, i was just saying that the likelyhood of them coming back over the years is decent but please don’t mistake that for wanting to get them back! if i never got another one back the rest of my life (ie. the paid as agreed and in full) well id be a very happy man
when i first read this reply i thought to myself “why wouldn’t he want to discuss this?” then i opened you link and its like i was reading my exact post only you came to the conclusion 5 years earlier
heck even down to the 250 a month senario i used and darn near the same interest rate! i swear when i typed this question i thought it was an orginal thought (even though i should’ve know better)…still fun to discuss but you’ve been around the block with this enough im sure
here’s to someone posting this question in 2012 w/ me posting the link to this topic…the more things change, the more they stay the same huh?
yes Micheal, like i said if you KNOW (or know more than likely) that they will stay the term of the loan than obviously the interest is great!
but remember if i sell a home 250/month for 48 months at 0% and you sell that same home for 60 months @ 18% (or whatever) the ONLY time you bring in a penny more than me is at month 49 PLUS you have to pay a load on your schedule B (assuming your doing a lot of deals) and i wouldn’t
and the point about selling your portfolio off so charging higher interest to get a better yeild also crossed my mind but i guess i would consider that more seriously if i knew for sure i was selling my note on the back end but i don’t
Really just a determination of what your business model is and how much you want to hassel with turn-over.
Given that fact, the interest charge is extra profit for me. I’m not queasy about letting them know my rates are high - 14.5 to 18%. I tell buyers, “I’m not the cheapest. If you have a way to borrow other money and pay cash that would definitely be the route to go in order for you to save the most money. I’ll even give you a discount if you can. But I’ll bet I’m cheaper than your credit card.”